The Implications of the Financial Reform Act for Foreign Banks, Financial Institutions and Financial Regulators

The financial stability oversight, liquidity emergency and orderly liquidation measures

International Business Law Journal, 2011 – number 5

Daniel Arthur Laprès

Avocat à la Cour d’Appel de Paris

Barrister and Solicitor Nova Scotia Canada

Paris, November, 2011

TABLE OF CONTENTS

1. - Introduction

1.1. - The financial crisis and the genesis of the financial reform

1.2. - The international compartment of the US banking and financial market

1.3. - General introduction to the US regulatory framework applicable to foreign banks and financial institutions

2. - Oversight of systemic financial risk

2.1. - Which foreign institutions might fall within the scope of application of the new regime

2.1.1. - Foreign banks and bank holding companies

2.1.2. - Application of the regime to foreign non-bank financial companies

2.2. - The role of the FSOC with respect to foreign entities

2.2.1. - Data collection

2.2.2. - Compulsion of submission to financial stability oversight

2.2.3. - Recommendations of imposition of prudential standards

2.2.4. - Prevention of evasion

2.2.5. - Consultation with foreign authorities

2.2.6. - Authority over systemic financial market utilities and clearing and settling activities of financial transactions among financial institutions

2.2.7. - FSOC authority over activities involving swaps

2.3. - The FRB’s additional jurisdiction

2.3.1. - Over banks and bank holding companies and non-bank financial companies

2.3.2. - FRB authority over FMUs

2.4. - Access to the US market

2.5. - Financial stability oversight cooperation with foreign authorities

3. - Emergency measures in case of liquidity events

3.1. - Liquidity events

3.2. - Implementation of emergency measures

3.3. - Prohibition of rescues of insolvent institutions

3.4 - Ranking of claims

4. - Orderly liquidation of systemically significant financial companies

4.1. - Implications of the operations of the OLA for foreign banking and financial institutions

4.2. - Studies of international coordination for the orderly liquidation of systemic banking and non-banking financial institutions

4.3. - Cooperation with foreign authorities

5. - Conclusion

1. - Introduction

The purpose of this comment is to highlight the implications of the systemic crisis prevention and management measures in the Financial Reform Act (FRA), which was signed by the President Obama on July 21, 2010, for foreign banks and financial institutions as well as for foreign regulatory authorities.

1.1. - The financial crisis and the genesis of the financial reform

Adopted in reaction to the financial crisis that had been simmering since the meltdown of the real estate market in the United States (US) from 2007, and which blew up on a global scale after the bankruptcy of Lehman Brothers on September 15, 2008, the FRA targeted the following major objectives:

· to clean up reckless lending practices on the US mortgage market on which perhaps as many as 50% of home mortgages that were being securitized had been granted without documentation confirming the borrower’s actual ability to repay,

· to rein in the trading of the derivative financial instruments that had spun out of official control, in particular that of credit default swaps on which the outstanding positions exceeded $ 60 trillion in 2008, that is almost the equivalent of one year’s world gross product,

· to institute a framework for overseeing, and where necessary liquidating, banks and financial institutions with systemic implications for US financial markets, to avoid reiterations of the bail-outs of institutions that are “too big to fail”.

Though generally recognized as the most important financial reform since the 1930s, the FRA cannot be qualified as comprehensive in so far as, for example, it leaves untouched the functioning of the so-called Government-sponsored entities, that are the National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), which in the fourth quarter of 2008 owned or guaranteed 75% of all newly originated mortgages and which, as of July 2010, either owned or had issued mortgage-backed securities representing 44.3% of all outstanding mortgage debt in the US.[1] But between 2001 and 2006, subprime and near-prime loans increased from 9% of securitized mortgages to 40%, while the market share of conventional mortgages dropped from 78.8% in 2003 to 50.1%.[2] Following upon the real estate bubble burst the Federal Housing Finance Agency (FHFA) on September 7, 2008, placed Fannie Mae and Freddie Mac into conservatorship and assumed upwards of $5,300,000,000,000 worth of risk.[3]

1.2. - The international compartment of the US banking and financial market

According to the 2009 Annual Report of the Federal Reserve, as of year-end 2009, 176 foreign banks from 53 countries were operating 204 state-licensed branches and agencies, of which 6 were insured by the Federal Deposit Insurance Corporation (FDIC) such that they were entitled to take retail deposits, and 50 federally-licensed branches and agencies, of which 4 were insured by the FDIC.[4] Foreign banks also held a controlling interest in 58 US commercial banks and 46 foreign banking organizations had financial holding company status. Altogether, the US offices of foreign banks at the end of 2009 controlled approximately 17% of US commercial banking assets. Foreign banks also owned three commercial lending companies and eight Edge Act and agreement corporations, through which they carried on activities abroad.[5]

Also at the end of 2009, 53 US banks were operating 557 branches in foreign countries and overseas areas of the US; 32 national banks were operating 503 of these branches, and 21 state member banks were operating the remaining 54. In addition, 18 non-member banks were operating 26 branches in foreign countries and overseas areas of the US.[6]

1.3. - General introduction to the US regulatory framework applicable to foreign banks and financial institutions

Since the Foreign Bank Supervision Enhancement Act of 1991, the Federal Reserve has exercised responsibility for supervising the US operations of foreign banking organizations.

In addition, depending on whether the foreign bank’s presence in the US is subject to federal or state jurisdiction, those operations are supervised respectively by the Office of the Comptroller of the Currency (OCC) or that of the competent state authority. New York, California, Florida and Illinois account for most of the branch assets and activities of foreign banks.

In order to have the right to accept deposits from the public (less than $ 100,000), an establishment must be approved by and is subject to supervision by the Federal Deposit Insurance Corporation (FDIC).

Foreign banks that own a US bank are by definition bank holding companies and foreign banks that operate branches or agencies on US territory are treated as if they were bank holding companies. Subject to certain exceptions, bank holding companies are prohibited form carrying on non-bank activities or activities not closely related to banking. In particular, under the Glass-Steagall Act,[7] commercial banks may not underwrite or deal in corporate debt or equity securities, and investment banks may not take deposits from the public. But these restrictions have been gradually relaxed, in particular by the Gramm-Leach-Bliley Act of 1999.

So-called financial holding companies may engage in a broader range of activities than bank holding companies, such as insurance underwriting and they may own both a commercial bank and an investment bank in the US. So a foreign bank that owns a US commercial bank may apply to become a financial holding company and then acquire or establish an investment bank. Bank holding companies may convert themselves into financial holding companies provided that they demonstrate to the Board of Governors of the Federal Reserve System (FRB) that they are well capitalized and well managed and have met community reinvestment requirements. Foreign banks that control a US bank subsidiary may opt for financial holding company status and foreign banks that have branches or agencies but no US deposit-taking institution may be treated as financial holding companies provided that they themselves, as well as where relevant their branches or agencies, meet the applicable standards.

Subject to special supervisory conditions, commercial banks, including those owned by foreign banks, may own investment banks; for example, they must deduct from their equity accounts the amounts of their capital in the subsidiary carrying on activities prohibited for commercial banks.

Foreign banks and bank holding companies may also own US subsidiaries without constituting a financial holding company provided that the activities that are prohibited for commercial banks do not exceed 25% of their gross revenues.

The FRA broadens the jurisdiction of the US banking regulatory authorities over large bank holding companies and draws under their jurisdiction financial institutions that had previously escaped comprehensive regulation, such as now defunct Lehman Brothers.

2. - Oversight of systemic financial risk

As regards banks and bank holding companies, the FRA innovates by:

· creating a new authority, the Financial Stability Oversight Council (FSOC), which will exercise circumscribed powers to monitor those that are of systemic magnitude to prevent shocks to the financial stability of the US and

· extending the FRB’s existing jurisdiction expressly to encompass surveillance and mitigation of systemic risk.

The FRA further innovates by subjecting systemic non-bank financial companies to the financial stability oversight of both the FSOC and the FRB.

2.1. - Which foreign institutions might fall within the scope of application of the new regime

In general, the new regulatory regime aims to prevent shocks to the financial stability of the US caused by “large inter-connected bank holding companies and non-bank financial companies”.[8]

2.1.1. - Foreign banks and bank holding companies

Non-US banks might be drawn under the new financial stability oversight regime where they control a US bank, such as to thereby have become a bank holding company, as well as where they have opened a US branch or agency such as to cause them to be treated as a bank holding company.

Under Section 102(a)(1) of the FRA, the new regulatory framework will apply to bank holding companies as defined in Section 2 of the Bank Holding Company Act of 1956, which covers any company that controls a bank or bank holding company.[9]

While foreign banks do not qualify as banks under the Bank Holding Company Act merely because they have an insured or uninsured branch in the US nor on the sole basis of carrying on business in the US that is incidental to their activities outside the US,[10] they are treated as bank holding companies when:

· they maintain a branch or agency in a state or

· they control a foreign bank that controls a commercial lending company organized under state law.[11]

2.1.2. - Application of the regime to foreign non-bank financial companies

Nonbank financial companies that are incorporated or organized in a country other than the US (other than companies that are, or are treated in the US as, bank holding companies) might fall within the scope of the new regime if they are predominantly engaged in financial activities, including through a branch in the US.[12]

For purposes of the application of the FRA’s provisions governing the FSOC and the additional powers of the FRB over certain nonbank financial companies and bank holding companies,[13] the term “financial activities”:

· means activities that are financial in nature,[14]

· includes the ownership or control of one or more insured depository institutions and

· does not include internal financial activities conducted for the company or any affiliate thereof, including internal treasury, investment, and employee benefit functions.[15]

A company is “predominantly engaged in financial activities” if:

· its annual gross revenues and those of all of its subsidiaries from activities that are financial in nature and, if applicable, from the ownership or control of one or more insured depository institutions, represent 85% or more of its consolidated annual gross revenues, or

· its consolidated assets and those of all its subsidiaries related to activities that are financial in nature and, if applicable, related to the ownership or control of one or more insured depository institutions, represent 85% or more of its consolidated assets.[16]

2.2. - The role of the FSOC with respect to foreign entities

The FSOC is invested with broad powers to collect from entities subject to its jurisdiction information relevant to its objectives and to compel their submission to financial stability oversight as well as to enhanced prudential standards.

2.2.1. - Data collection

The FSOC may require the submission of periodic and other reports from any nonbank financial company or bank holding company for the purpose of assessing the extent to which a financial activity or financial market in which the nonbank financial company or bank holding company participates, or the nonbank financial company or bank holding company itself, poses a threat to the financial stability of the US.[17]

The FSOC may require bank holding companies with consolidated assets of $ 50 billion or more and non-bank financial companies supervised by the FRB to communicate to it periodic reports about their activities and those of their subsidiaries that could, under adverse circumstances, disrupt financial markets or affect the overall financial stability of the US.[18]

2.2.2. - Compulsion of submission to financial stability oversight

If it determines that material financial distress at a foreign nonbank financial company, or the nature, scope, size, scale, concentration, interconnectedness or mix of its activities could pose a threat to the financial stability of the US, the FSOC, on a non-delegable basis and by a vote of not fewer than 2⁄3 of the voting members then serving, including an affirmative vote by the Chairperson, may determine that the foreign nonbank financial company shall be supervised by the FRB and shall be subject to such prudential standards as the latter may set down.[19]

In making such determinations, the FSOC must consider:

· the extent of the leverage of the company,

· the extent and nature of its US related off-balance-sheet exposures,

· the extent and nature of its transactions and relationships with other significant nonbank financial companies and significant bank holding companies,

· its importance as a source of credit for US households, businesses, and state and local governments and as a source of liquidity for the American financial system,

· the importance of the company as a source of credit for low-income, minority, or underserved communities in the US, and the impact that its failure would have on the availability of credit in those communities,

· the extent to which assets are managed rather than owned by the company and the extent to which ownership of assets under its management is diffuse,

· the nature, scope, size, scale, concentration, inter-connectedness, and mix of its activities,

· the extent to which the company is subject to prudential standards on a consolidated basis in its home country that are administered and enforced by a comparable foreign supervisory authority,

· the amount and nature of the company’s US financial assets,

· the amount and nature of the liabilities of the company used to fund activities and operations in the US, including the degree of reliance on short- term funding and

· any other risk-related factors that the FSOC deems appropriate.[20]

After its inaugural meeting on October 1, 2010, the FSOC published a notice of proposed rule-making that essentially expresses its commitment to implement the mission as regards foreign institutions as defined in the FRA.[21]

The FSOC must give written notice of submission to financial stability oversight to the concerned non-bank financial company that has 30 days to contest the determination.[22] The final decision of the FSOC is subject to judicial review.[23]

In exercising these duties with respect to foreign non-bank financial companies, foreign-based bank holding companies, and cross-border activities and markets, the FSOC must consult with appropriate foreign regulatory authorities, to the extent appropriate in the circumstances.[24]

Non-bank financial companies that are subjected to financial stability oversight must register with the FRB within 180 of the determination.[25]

2.2.3. - Recommendations of imposition of prudential standards

Under Section 115(a)(1) of the FRA, in order to prevent or mitigate risks to the financial stability of the US that could arise from the material financial distress, failure, or ongoing activities of large, interconnected financial institutions, the FSOC may make recommendations to the FRB concerning the establishment and refinement of prudential standards and reporting and disclosure requirements applicable to large, interconnected bank holding companies and nonbank financial companies supervised by the FRB and

· that are more stringent than those applicable to bank holding companies and nonbank financial companies that do not present similar risks to the financial stability of the US and

· that increase in stringency, based on the following considerations:

· risk-based capital requirements,

· leverage limits,

· liquidity requirements,

· resolution plan and credit exposure requirements,

· concentration limits,

· contingent capital requirements,

· enhanced public disclosures

· short-term debt limits and

· overall risk management requirements.

In making such recommendations, the FSOC may:

· differentiate among companies that are subject to heightened standards on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, financial activities (including those of their subsidiaries), size, and any other risk-related factors that it deems appropriate or

· recommend an asset threshold that is higher than $50 billion for the application of any of the above standards other than risk-based capital requirements and leverage limits.[26]

In making recommendations concerning enhanced prudential standards applicable to foreign-based bank holding companies or foreign nonbank financial companies supervised by the FRB, the FSOC must:

· give due regard to the principles of national treatment and equality of competitive opportunity and

· take into account the extent to which the foreign-based bank holding company or the foreign nonbank financial company is subject on a consolidated basis to home country standards that are comparable to those applied to financial companies in the US.[27]

The FSOC may make recommendations to the FRB with respect to the imposition of contingent capital requirements,[28] resolution plans,[29] concentration limits,[30] enhanced public disclosures[31] and short-term debit limits.[32]

If the FSOC determines that the conduct, scope, nature, size, scale, concentration, or interconnectedness of activities or practices could create or increase the risk of significant liquidity, credit, or other problems spreading among bank holding companies and nonbank financial companies, financial markets of the US, or low-income, minority, or under-served communities, it may issue recommendations to their primary financial regulatory agencies to apply new or heightened standards and safeguards to any of their financial activities or practices.[33]

2.2.4. - Prevention of evasion

In order to avoid evasion of the financial stability oversight regime, the FSOC, on its own initiative or at the request of the FRB, may determine, on a non-delegable basis and by a vote of not fewer than 2⁄3 of the voting members then serving, including an affirmative vote by the Chairperson, that:

· where material financial distress related to, or the nature, scope, size, scale, concentration, interconnectedness, or mix of, the financial activities conducted directly or indirectly by a company incorporated or organized under the laws of the US or any state or the financial activities in the US of a company incorporated or organized in a country other than the US would pose a threat to the financial stability of the US and

· where the company is organized or operates in such a manner as to evade the financial stability oversight regime,

· then such financial activities will be supervised by the FRB and will be subject to heightened prudential standards.[34]

In such event, the concerned company may place its financial activities and those of its subsidiaries in an intermediate holding company, which would then be subject to financial stability oversight and to prudential standards as if it were a nonbank financial company supervised by the FRB.[35] The non-financial activities of the company would not be subject to prudential supervision.[36]

2.2.5. - Consultation with foreign authorities

In exercising its jurisdiction with respect to foreign non-bank financial companies, foreign-based bank holding companies, and cross-border activities and markets, the FSOC must consult with appropriate foreign regulatory authorities, to the extent appropriate in the circumstances.[37]

2.2.6. - Authority over systemic financial market utilities and clearing and settling activities of financial transactions among financial institutions

The definition of ”financial market utilities” (FMUs) includes any person that manages or operates a multilateral system for the purpose of transferring, clearing, or settling payments, securities or other financial transactions among financial institutions or between financial institutions and the person.[38]

Then term “financial institution” includes not only US subsidiaries but also branches and agencies of foreign banks.[39]

Providers of services “integral” to the operation of FMUs, whether affiliates or not, and whether they intervene on site or off, are subject to examination for their compliance with the standards imposed under the new regime.[40]

The FSOC, on a non-delegable basis and by a vote of not fewer than 2⁄3 of members then serving, including an affirmative vote by its Chairperson, will designate those FMUs or payment, clearing, or settlement activities that it determines are, or are likely to become, systemically[41] important.[42] In making such determinations, the FSOC must take into consideration the following:

· the aggregate monetary value of transactions processed by the FMU or carried out in connection with the payment, clearing, or settlement activity,

· the aggregate exposure of the FMU or a financial institution engaged in payment, clearing, or settlement activities to its counterparties,

· the relationship, interdependencies or other inter-actions of the FMU or payment, clearing, or settlement activity with other FMUs or payment, clearing, or settlement activities,

· the effect that the failure of or a disruption to the FMU or payment, clearing, or settlement activity would have on critical markets, financial institutions, or the broader financial system and

· any other factors that the FSOC deems appropriate.[43]

The FSOC must give advance notice to concerned FMUs and the latter have the right to contest the actions, including in hearings.[44] The FSOC can waive such requirements if it determines, by an affirmative vote of not fewer than 2⁄3 of members then serving, including an affirmative vote by its Chairperson, that the waiver or modification is necessary to prevent or mitigate an immediate threat to the financial system posed by the FMU or the payment, clearing, or settlement activity.[45]

Where it determines specific prudential requirements as proposed by the CFTC or the SEC and upon their revision by the FRB that are insufficient, the FSOC, upon an affirmative vote by not fewer than 2/3 of its members then serving, may prescribe appropriate risk management standards.[46]

2.2.7. - FSOC authority over activities involving swaps

If the FSOC determines that the provisions in the FRA are insufficient to effectively mitigate systemic risk and protect taxpayers, it may rule that swaps entities may no longer access federal assistance with respect to their swap, security-based swap or other activities. Any such determination must be made on an institution-by-institution basis, and requires a favorable vote of not fewer than two-thirds of its members, which must include the vote by its Chairman, the Chairman of the FRB, and the Chairperson of the FDIC.[47]

Generally, the FSOC will be responsible for assessments of the systemic proportions of covered FMUs and of their activities.

If conflicts arise between the CFTC, the SEC and the federal banking agencies already competent with respect to regulation of payment, clearing and settlement involving commodities or securities or with respect to depository institutions, as the case may be, as regards their new supervisory tasks,[48] the FSOC will designate the appropriate agency.[49]

The FSOC enjoys the powers to qualify as falling within the scope of its authority activities as amounting to “payment, clearing and settlement”[50] as well as to qualify transactions as “financial”.[51]

2.3. - The FRB’s additional jurisdiction

2.3.1. - Over banks and bank holding companies and non-bank financial companies

Under Section 121 of the FRA, where it determines that a bank holding company with total consolidated assets of $50 billion or more or a non-bank financial company under its supervision poses a grave threat to the financial stability of the US, the FRB, upon an affirmative vote of not fewer than 2⁄3 of the voting members of the FSOC then serving, will:

· limit its ability to merge with, acquire, consolidate with, or otherwise become affiliated with another company,

· restrict its ability to offer financial products,

· require it to terminate one or more activities,

· impose conditions on the manner in which it conducts one or more activities or

· where such actions are inadequate to mitigate a threat to the financial stability of the US, require it to sell or otherwise transfer assets or off-balance-sheet items to unaffiliated entities.

In making such determinations, the FRB must take into account the factors listed in Section 113(b)(2) as detailed above.[52]

Under Section 121(d) of the FRA, when the FRB prescribes such regulations applicable to foreign nonbank financial companies subject to its supervision and foreign-based bank holding companies, it must:

· give due regard to the principle of national treatment and equality of competitive opportunity and

· take into account the extent to which the foreign nonbank financial company or foreign-based bank holding company is subject on a consolidated basis to home country standards that are comparable to those applied to financial companies in the US.[53]

The FRB must also respect these constraints in applying such prudential standards to any foreign non-bank financial company under its supervision or any foreign-based bank holding company.[54]

The FRB must promulgate regulations, in consultation with the FSOC, setting down criteria for exempting certain types or classes of foreign nonbank financial companies from supervision. In developing those criteria, it must take into account the same factors as those used in determining whether a foreign nonbank financial company is to be subjected to its supervision.[55]

2.3.2. - FRB authority over FMUs

The FRB, in consultation with the FSOC and the competent federal agencies, will prescribe risk management standards, taking into consideration relevant international standards and existing prudential requirements governing:

· the operations related to the payment, clearing, and settlement activities of designated FMUs and

· the conduct of designated activities by financial institutions.[56]

The FRB may determine that existing prudential requirements of the CFTC, the SEC or both with respect to designated clearing entities and financial institutions engaged in designated activities for which they act as the supervisory agency or the appropriate financial regulator are insufficient to prevent or mitigate significant liquidity, credit, operational, or other risks to the financial markets or to US financial stability.[57]

The FRB may authorize a Federal Reserve bank under section 10B of the Federal Reserve Act to provide to a designated FMU discount and borrowing privileges only in unusual or exigent circumstances, upon the affirmative vote of the FRB and upon a showing by the designated FMU that it is unable to secure adequate credit accommodations from other banking institutions.[58]

The FRB may, after consulting with the primary regulatory agency (federal banking agency, SEC, CFTC) and upon an affirmative vote by a majority the FSOC, take enforcement action against a designated FMU if it has reasonable cause to conclude that either:

· an action engaged in, or contemplated by, a designated FMU poses an imminent risk of substantial harm to financial institutions, critical markets or the broader financial system of the US or

· the condition of a designated FMU poses an imminent risk of substantial harm to financial institutions, critical markets, or the broader financial system and the imminent risk of substantial harm precludes the FRB’s use of the usually applicable procedures.[59]

2.4. - Access to the US market

Section 173 of the FRA adds to the criteria to be applied in deciding whether to allow a foreign banking institution or broker-dealer to establish in the US or in deciding whether to terminate such right that the institution cannot present

a risk to the stability of US financial system, whether the home country of the foreign bank has adopted, or is making demonstrable progress toward adopting, an appropriate system of financial regulation for the financial system of such home country to mitigate such risk.

2.5. - Financial stability oversight cooperation with foreign authorities

Section 175(b) of the FRA provides that the Chairperson of the FSOC, in consultation with its other members, must regularly consult with the financial regulatory entities and other appropriate organizations of foreign governments or international organizations on matters relating to systemic risk to the international financial system.

Before requiring the submission of reports from a foreign nonbank financial company or foreign-based bank holding company, the FSOC, acting through the Office of Financial Research, must to the extent appropriate, consult with the foreign regulator of such company and, whenever possible, rely on information already being collected by such foreign regulator.[60]

Even in making emergency determinations, the FSOC must consult with the appropriate home country supervisor, if any, of the foreign nonbank financial company.[61] In exercising its duties with respect to foreign nonbank financial companies, foreign-based bank holding companies, and cross-border activities and markets, the FSOC must consult with appropriate foreign regulatory authorities.[62]

Before requiring the submission of a report from any financial company that is regulated by a Federal Reserve member agency, any primary financial regulatory agency or a foreign supervisory authority, the Office of Financial Research must coordinate with such agencies or authority, and must, whenever possible, rely on information available from such agencies or authority.[63]

The FRB and the Secretary of the Treasury (the Secretary) must consult with their foreign counterparts and through appropriate multilateral organizations to encourage comprehensive and robust prudential supervision and regulation for all highly leveraged and interconnected financial companies.[64]

The President, or his/her appointee, may coordinate through all available international policy channels, similar policies as those found in US law relating to limiting the scope, nature, size, scale, concentration, and interconnectedness of financial companies, in order to protect financial stability and the global economy.[65]

The Chairperson of the FSOC, in consultation with its other members, must regularly consult with the financial regulatory entities and other appropriate organizations of foreign governments or international organizations on matters relating to systemic risk to the international financial system.[66]

3. - Emergency measures in case of liquidity events

The Secretary may request the FDIC and the FRB to determine whether a liquidity event exists that warrants use of an authorized guarantee program.[67]

The FRB may not establish any emergency program or

facility without the prior approval of the Secretary.[68]

3.1. - Liquidity events

The term “liquidity event” means:

· an exceptional and broad reduction in the general ability of financial market participants:

o to sell financial assets without an unusual and significant discount or

o to borrow using financial assets as collateral without an unusual and significant increase in margin or

· an unusual and significant reduction in the ability of financial market participants to obtain unsecured credit.[69]

Any such determination must:

· be written and

· contain an evaluation of the evidence that—

o a liquidity event exists,

o failure to take action would have serious adverse effects on financial stability or economic conditions in the US and

o actions are needed to avoid or mitigate potential adverse effects on the US financial system or economic conditions.[70]

3.2. - Implementation of emergency measures

Upon the determination of both the FDIC (by a vote of not fewer than 2⁄3 of its members then serving) and the FRB (upon a vote of not fewer than 2⁄3 of its members then serving) that a liquidity event exists that warrants use of an authorized guarantee program and with the written consent of the Secretary, then:

· the FDIC must create a widely available program to guarantee obligations of solvent insured depository institutions or solvent depository institution holding companies (including any affiliates thereof) during times of severe economic distress, except that a guarantee of obligations may not include the provision of equity in any form[71] and

· the Secretary (in consultation with the President) must determine the maximum amount of debt out standing that the FDIC may guarantee and the President will then transmit to Congress a written report on the FDIC’s plan to issue guarantees up to that maximum amount and a request for its approval.[72]

During times of severe economic distress, upon the written determination of the FDIC and the FRB, the former must create a widely available program to guarantee obligations of solvent insured depository institutions or solvent depository institution holding companies (including any affiliates thereof), except that a guarantee of obligations may not include the provision of equity in any form.[73]

In connection with any such program, the Secretary (in consultation with the President) must determine the maximum amount of debt outstanding that the FDIC may guarantee, and the President may transmit to Congress a written report on its plan to exercise the authority to issue guarantees up to that maximum amount and a request for approval of such plan. The FDIC may only issue guarantees up to that specified maximum amount upon passage of the joint resolution of approval.[74]

If an insured depository institution or depository institution holding company participating in an emergency program, or any participant in a debt guarantee program established pursuant to the Federal Deposit Insurance Act defaults on any obligation guaranteed by the FDIC after the date of enactment of the FRA, the latter must:

· appoint itself as receiver for the insured depository institution that defaults and

· with respect to any other participating company that is not an insured depository institution that defaults:

· require:

o consideration of whether the company should be resolved and

o the company to file a petition for bankruptcy if the FDIC is not appointed receiver within 30 days of the date of default,

· file a petition for involuntary bankruptcy on behalf of the company.[75]

In consultation with the Secretary, the FRB must adopt regulations defining policies and procedures governing emergency lending to ensure that any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company, and that the security for emergency loans is sufficient to protect taxpayers from losses and that any such program is terminated in a timely and orderly fashion.[76]

A program or facility that is structured to remove assets from the balance sheet of a single and specific company, or that is established for the purpose of assisting a single and specific company avoid bankruptcy, resolution under the FRA, or any other federal or state insolvency proceeding, must not be considered a program or facility with broad-based eligibility.[77]

3.3. - Prohibition of rescues of insolvent institutions

The FRB must establish procedures to prohibit borrowing from programs and facilities by borrowers that are insolvent. Such procedures may include a certification from the chief executive officer (or other authorized officer) of the borrower, at the time the latter initially borrows under the program or facility (with a duty by the borrower to update the certification if the information in the certification materially changes), that it is not insolvent. A borrower will be considered insolvent, if it is in bankruptcy, resolution under the FRA or any other federal or state insolvency proceeding.[78]

The policies and procedures established by the FRB will require that a federal reserve bank assign, consistent with sound risk management practices and in such manner as to ensure protection for the taxpayer, a lendable value to all collateral for a loan executed by a federal reserve bank in determining whether the loan is satisfactorily secured.[79]

3.4 - Ranking of claims

If an entity to which a federal reserve bank

has provided a loan becomes subject to financial stability oversight as a systemic institution at any time while such loan is outstanding, and the federal reserve bank incurs a realized net loss on the loan, then it will have a claim equal to the amount of the net realized loss against the covered entity, with the same priority as an obligation to the Secretary.[80]

4. - Orderly liquidation of systemically significant financial companies

A mechanism is instituted for the orderly liquidation of bank holding companies, non-bank financial companies and companies predominantly engaged in financial activities when they are systemically significant. The intention is to avoid the need for taxpayer bailouts of companies that are “too big to fail”.

While the failure of commercial banks was covered in the regulatory framework that pre-dated the financial crisis of 2008 by charging the FDIC with their orderly liquidation, including guarantees of retail customer’s deposits up to $ 100,000, no such framework had been set in place for non-bank financial companies of systemic proportions such as Lehman Brothers.

The FRA extends the FDIC’s authority, upon being appointed by the Secretary, to act as receiver and eventually as liquidator of non-bank financial companies which are in default or in danger of going into default when their failure would have serious adverse effects on financial stability in the US, and there is no viable private sector alternative to avoid the default. The FDIC will exercise subsidiary authority to liquidate insurance companies where the competent state regulators have not intervened within 60 days of the Treasury’s determination of the need for orderly liquidation.[81]

4.1. - Implications of the operations of the OLA for foreign banking and financial institutions

To be subject to the orderly liquidation provisions of the FRA, a company would have to be organized or incorporated under federal or state law, so that non-US banks and financial institutions are excluded from the regime set down in the FRA. But their US subsidiaries would be subject to the regime and there are other respects in which foreign banks and institutions may be affected by its application.

In the process of the orderly liquidation of a covered financial company in default, the FDIC as receiver may transfer to another financial institution any qualified financial contracts and related claims and property but may not make such transfer to a foreign bank, financial institution organized under the laws of a foreign country, or a branch or agency of a foreign bank or financial institution unless, under the law applicable to such bank, financial institution, branch or agency, to the qualified financial contracts, and to any netting contract, any security agreement or arrangement or other credit enhancement related to one or more qualified financial contracts, the contractual rights of the parties to such financial contracts are enforceable substantially to the same extent as permitted under the FRA.[82]

4.2. - Studies of international coordination for the orderly liquidation of systemic banking and non-banking financial institutions

The Comptroller General is mandated to conduct a study and render a report within one year of the FRA’s adoption regarding international coordination relating to the orderly liquidation of financial companies under the Bankruptcy Code. His office is to evaluate the following matters as regards the bankruptcy process for financial companies:

· the extent to which international coordination currently exists,

· what mechanisms and structures currently exist for facilitating international cooperation,

· what are the barriers to effective international coordination and

· what means might be used to increase and make more effective international coordination.[83]

The FRB, in consultation with the Administrative Office of the US Courts, must conduct a study regarding international coordination relating to the resolution of systemic financial companies under the US Bankruptcy Code and applicable foreign law.[84]

4.3. - Cooperation with foreign authorities

The FDIC, as receiver for a covered financial company, must coordinate, to the maximum extent possible, with the appropriate foreign financial authorities regarding the orderly liquidation of any covered financial company that has assets or operations in a country other than the US.[85]

The FDIC, as receiver for any covered financial company, and for purposes of carrying out any power, authority, or duty with respect to a covered financial company:

· may request the assistance of any foreign financial authority and provide assistance to any foreign financial authority, as if the covered financial company were an insured depository institution, the FDIC were the appropriate federal banking agency for the company, and any foreign financial authority were the foreign banking authority and

· may maintain an office to coordinate foreign investigations or investigations on behalf of foreign financial authorities.[86]

5. - Conclusion

As most specialists have observed, the actual implications of the FRA, including for foreign institutions and regulators, will depend to a large extent on the results of the some 60 studies and reports it mandates and on the contents of the some 250 sets of implementing regulations for which it provides.